Larry White on the Slow Recovery

Steven Horwitz

Over at Free Banking, Larry offers an alternative to the "it's all nominal" interpretation of the slow recovery associated with Scott Sumner and the Market Monetarists. In so doing, he also argues why their cure (further monetary expansion) is both not needed and positively harmful. Larry's conclusion:

the weak recovery today has more to do with difficulties of real
adjustment. The nominal-problems-only diagnosis ignores real
malinvestments during the housing boom that have permanently lowered our
potential real GDP path. It also ignores the possibility that the
“natural” rate of unemployment has been hiked by the extension of
unemployment benefits. And it ignores the depressing effect of
increased regime uncertainty.

To prefer 5% to the current 4% nominal GDP growth going forward, and a
fortiori to ask for a burst of money creation to get us back to the
previous 5% bubble path, is to ask for chronically higher monetary
expansion and inflation that will do more harm than good.

Comments

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RA, the main poster for the Free Exchange blog on the Economist web site, has been a cheerleader for Sumner for years. He is exstatic about the change in Fed policy and has declared victory for Sumner as a main influence on the Fed.

However, RA has already started giving excuses for why it might not produce the wonderful results he and Sumner have declared for years.

We all recognize that potential output may have shifted to a lower growth path. We don't think that is a reason for slower spending growth--ever.

Since we don't know that potential output is on a lower growth path, or how much lower, and even if it is a lot lower, still spending should not drop, then keeping to the previous growth path is a sensible option.

It's the distortions, Bill. Printing more greenbacks, electronic or otherwise, will not cure them but will almost certainly make them worse. Sorry you don't see that. Austrians have been explaining it for a century now.

Bill, do you not believe that there was something of an asset-market bubble ca. 2004-7, that it was encouraged by the Fed's decision to maintain a low (indeed negative) FFR, and that rising asset prices, particularly in real estate, had as their counterpart robust spending growth, much of it home-equity financed? Finally, do you think it was in fact "sensible," in light of the uncertain value of "potential" output, for the Fed to have maintained the stance it had then, that is, to have stayed on the spending path it actually was on, instead of attempting to "lean against the wind" a bit, as Taylor and many others have argued? If you do not, surely you should allow that it isn't "ridiculous" to speak of a "bubble path" of spending.

NGDP can grow too fast, as well as too slow; when it does the former, people may have a false impression of sustainable real output--as when they are living off of unsustainable equity values. In that case, why should we not accept some permanent decline in NGDP consistent with the return to realistic equity values and sustainable real income growth? That's not the same as defending a large collapse of NGDP, which itself can cause growth to fall below its sustainable natural ("potential") level. It seems to me that it is just keeping true to the spirit of NGDP level targeting, by suggesting that we ought to "make up" for spurts of excessively rapid NGDP growth just as we should make up for episodes when NGDP growth falls below its ideal path.

I've not intended to imply any knowledge of magnitudes here--I'm not saying that the excess of NGDP was very great. I'm speaking as a matter of principal. The empirics of "correct" NGDP growth seem to me about as thorny of those for the potential GDP itself.

In a situation where people are afraid to hire more people and to start new things due to regime uncertainty and yet there are artificially low interest rates, one would expect businesses to invest in labor-saving devices, since it is cheaper to buy them due to the low interest rates (which will in fact be kept below 0% with QE3). This would result in slow job creation even as one gets strong economic growth. However, what do you suppose is going to happen if there continues to be a disconnect between economic growth from improvements in efficiency and employment?